Why OCF Differs from Net Profit
Net profit is an accounting measure; operating cash flow is a cash measure. Three categories of adjustments bridge them: (1) Non-cash charges โ depreciation and amortisation are expenses on the income statement but don't consume cash; (2) Working capital timing โ revenue recognised before cash is collected increases AR (bad for cash); (3) Accrued liabilities โ expenses recognised before they're paid increase AP (good for cash).
For SaaS businesses, OCF often differs dramatically from net income due to annual contract prepayments. A SaaS company that bills annually collects 12 months of cash upfront but only recognises one month of revenue โ making OCF much stronger than net income in high-growth periods.
SaaS Cash Flow Advantage
SaaS companies billing on annual prepayments create deferred revenue โ cash collected before it's recognised as revenue. This makes OCF systematically higher than net income during growth periods. This is a significant advantage: the business is self-funding its growth from future revenue collected today. It's why SaaS businesses often require less capital than their net losses suggest.
Three Types of Cash Flow
The cash flow statement has three sections: Operating (cash from core business), Investing (cash from buying/selling assets and investments), and Financing (cash from debt and equity). OCF is the most important โ it measures whether the business generates cash from its core activity.
A healthy business generates positive OCF. It may have negative investing cash flow (buying equipment) and negative financing cash flow (repaying debt) while still net-positive overall. The danger is a business with negative OCF funded by equity raises โ this works only as long as investors continue to fund it.
20โ25%
Target OCF margin for mature SaaS
+ D&A
OCF typically > net income by D&A add-back
Annual
SaaS prepayments boost OCF vs net income
FCF
OCF minus CapEx = free cash flow